Because we find ourselves in uncertain financial times, I think caution is particularly important as investment strategies are formulated for the year ahead. Certainly, that is the approach I favor.
Past performance is the primary determinant of financial planning — you examine how things have unfolded in the past and move forward accordingly. But this year in the real estate investment business and the multifamily business, it’s foolhardy for anyone to think that rents will continue to grow as rapidly as they’ve grown over the last year or two. In fact, there appears to be a little bit of a slowdown already.
I don’t think it will be negative rent growth, but it’s going to go back to the pre-pandemic norm. It’s been double-digit percentage rent growth over the last year. Just projecting with everything that’s going on, it’s going to be closer to 3 percent or 4 percent in most markets. That makes a dramatic difference in the process, in terms of where you think you’ll be next year.
The other part of the investment equation is the use of debt. Where there’s long-term debt on existing assets, no adjustment is necessary. Same for loans, if you were able to get them over the last year in the 3 percent range, and if they’re long-term and fixed.
But people need to be mindful of the current interest-rate environment if they have loans that are coming due or need to be refinanced now or sometime next year.
Ditto if they have made new acquisitions. Those who find themselves in that boat can count on a much larger interest cost, or a debt-service carrying cost, than they’ve had in the past.
Advice and strategy
Rod Khleif, a real estate investor, mentor and coach, offered a primer about the current investment environment in a post on Forbes, noting that historically high inflation rates have led to the Federal Reserve raising interest rates at a clip not seen since 2018.
He cited other evidence of trouble, like a bearish stock market, the specter of layoffs and revised earnings forecasts by several companies. Moreover, he pointed out that mortgage applications were at a 22-year low.
While these are undoubtedly uncertain times, it is not comparable to 2020, when the pandemic first struck the U.S. At that point there was even some degree of panic, a feeling that we had never seen anything like this. And we hadn’t. But the multifamily sector not only survived; it thrived.
With the current economy there’s a sense, at least in my mind, that we’ve seen this before. Those of us who have been in the business for a while have seen the cycles. We’ve seen the ups and downs. It’s manageable.
It just requires adjustment and recalibration, rather than just putting your head in the sand and assuming everything’s going to go along the way it’s gone along the last couple years.
Planning for 2023
With that in mind, here are three tips to help you solidify your 2023 multifamily investment plan:
No plan is foolproof: Any projection of where you’re going to be in a year, two years or three years from now is wrong, 100 percent of the time. Fortunately for all of us in the multifamily business, it has been wrong for the better the last few years. But knowing that expectation doesn’t match reality, you’ve got to be ready to make adjustments on the fly. Who knows how long the interest-rate environment is going to be elevated? I don’t know. It depends which economist or which day of the week you read someone in The Wall Street Journal.
Remain calm: None of these developments represents an existential threat or a major disruptive event to the industry. It’s just a correction. The fundamentals of the business are still very strong.
Keep things in perspective: Having followed my father and grandfather into the real estate business, I learned about the ebbs and flows of the economy and have never allowed them to unsettle me. Recently I was discussing with someone the fact that the interest rate for a multifamily acquisition is in the fives, which some people think is very high, compared to when it was three. Being a guy that had been around, I said, “I remember when I got a commitment from the bank years ago, and they agreed to provide us with debt and a 7 percent interest rate. And I was doing high-fives, thinking, it’s unbelievable how cheap this is.” We managed to survive that just fine.
The bottom line is that investors in multifamily real estate need to formulate their plans with eyes wide open, knowing that in all likelihood they will have to revise those plans in the weeks and months ahead. Yes, there are some concerning economic trends. But the sector remains on solid footing, and figures to remain so.
Michael H. Zaransky is the founder and managing principal of MZ Capital Partners in Northbrook, Illinois. Founded in 2005, the company deals in multifamily properties.